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Morningstar | Sigma Puts on a Stoic Front After a Year of Living Dangerously

It was important for Sigma to deliver a result and an outlook inspiring confidence among shareholders, with some still smarting over its decision to spurn Australian Pharmaceutical Industries', or API's, merger proposal.

A fiscal 2019 underlying EBIT of AUD 76 million (down 16%) was a good start, compared with the AUD 75 million guidance which was also our estimate. Granted, EBITDA/cash conversion was low at 35%, as cash conversion cycle increased by 4 days to 36. This, combined with the capital expenditure program on distribution centre upgrades (around AUD 100 million), pushed net debt to AUD 243 million, up from AUD 114 million a year ago. However, with the investment program largely complete and reduced working capital burden from the Chemist Warehouse, or CW, contract loss, Sigma's debt is set to reduce to around AUD 100 million by the end of fiscal 2020, with net debt/EBITDA falling below 1.5 times.

It also helped that management reaffirmed the AUD 100 million efficiency benefit from Project Pivot. It is a transformation program designed to offset the impact of the CW contract loss (another hard decision made by management not to renew), and return EBITDA back to fiscal 2019 level of AUD 90 million by fiscal 2023 (our current forecast is AUD 86 million).

Unfortunately, the path to that fiscal 2023 sustainable earnings base will be rocky. Our unchanged fiscal 2020 EBITDA forecast of AUD 60 million implies a 34% fall before the trajectory becomes positive thereafter to reach AUD 89 million in five years' time.

This near-term challenge and the execution risks related to Project Pivot are likely why shares in narrow-moat-rated Sigma are trading 19% below our unchanged AUD 0.68 fair value estimate. That is understandable, as is some shareholders' frustration for Sigma's rejection of API's overtures. However, there is no point crying over spilt milk (CW loss, API no-deal), and there is value in Sigma shares on a long-term fundamental, stand-alone basis.

Sigma's underlying net profit aftertax of AUD 46 million was down 23% year on year and 7% below our AUD 50 million forecast. The pharmaceutical wholesaler declared a fully franked final dividend of AUD 2 cents per share, bringing the full-year dividend to AUD 3.5 cents per share and representing a 97% payout of reported NPAT. We assume the high dividend payout to continue in line with management's stated policy, at 92% of reported NPAT in our forecast period.

The decline in top-line sales was driven by a AUD 226 million, or 50%, decrease in Hepatitis C medication sales in the period. Excluding Hep C, group sales revenue was up 2.9%, supported by a full year contribution from acquired MPS medication and MIA, and growth in Sigma Hospitals. We expect revenue to decline 23% and 18% respectively in fiscal 2020 and 2021, reflecting the progressive dent from losing the CW contract. With full exit of the CW contract, we expect revenue growth to recover at 1.5% per year from fiscal 2022. The transition of CW is expected to be finalised by August 2019 and the relevant working capital is to be released between June to October 2019.

Under Project Pivot, Sigma expects to realise 60% of the AUD 100 million-plus efficiency gains from optimising and rationalising its distribution infrastructure network in the second half of 2019 calendar year and redundancies of staff in its distribution centre network; 25% from a general business restructure; and the remaining 15% from better control of budgeting and spending. Regarding timeframe, 60% of efficiency gains (on a run-rate basis) are expected to be delivered in fiscal 2020 with the rest flowing in fiscal 2021. We expect Sigma to be aggressive in filling capacity growth from current investment in distribution centres and automation.